Colleges Sue Former Students for Defaulted Loans

While many graduates struggle to stay on top on monthly student loan payments, some are finding that defaulting on certain loans can have litigious results.

Bloomberg reports that disadvantaged borrowers have defaulted on almost $1 billion in Perkins loans, a program designated for students with serious financial need, and schools such as Yale University, the University of Pennsylvania and George Washington University have sued former students over nonpayment.

Although most student loans are awarded by and repaid to the federal government, Perkins loans are awarded by colleges who then use the repaid loans to continue funding the program for other eligible students.

Colleges are required to pursue defaulted loans aggressively with the expectation that the borrower is capable of repaying the debt but is unwilling, yet many schools fail to take legal action because of associated costs, says Mark Kantrowitz, publisher of FinAid and FastWeb.

“Even though the college itself doesn’t pay the cost of filing the suit, the revolving student loan funds get charged for the cost of the lawsuit,” he says.

Kantrowitz points out that suing a defaulted borrower is always a last resort for schools after contacting the student to discuss repayment options similar to other federal loan programs such as income based repayment, deferment, and forbearance.

“They use wage garnishment and treasury offset of income tax refunds to try to collect the defaulted debt, but in some cases you have people who are self employed who just don’t want to pay back the debt, even though they owe it,” he says.

Why Students Default

Predictors of default rates include interest rates, graduation rates, the amount of debt the student takes on and unemployment rates, according to Kantrowitz.

“I expect that since we’ve started seeing some improvement in unemployment rates, we’re going to start seeing improvement in the default rates, maybe this year, maybe the year after,” he says.

“You have to repay the debt whether or not your education and your job search work out the way you hope they will,” she says. “The problem is that people need a safety net—things happen and there isn’t anything wrong with trying to better yourself and your financial situation by going to school even though you come from a family that can’t afford to pay for it out of pocket.”

Even if graduates are gainfully employed, the amount of debt they have can override any progress made on repayment.

“With $80,000 worth of debt, even if you get a job that pays $60,000, which about the average for a lot of college-level jobs, you’re still below the water and the potential for you to default is much higher,” says Jonathan Robe, research fellow for the Center for College Affordability and Productivity. “I think that’s what’s happening here--the students feel like they just flat out don’t have the money.”

Students might not be aware of their repayment options, particularly if they leave school before completing their degree, says Kantrowitz.

“Students who drop out are four times more likely to default on their student loans than students who graduate and part of the reason for this is that students who graduate go through what’s called exit counseling, which reviews their repayment options.”

Repayment Options

The Perkins loan program allows borrowers more time to get on their feet to repay loans after a nine-month grace period versus the six-month period typical of many federal loans.

Although the school acts as the lender, students still have a variety of options in working out a repayment plan as discussed in exit counseling, says Kantrowitz.

“Nothing stops the student from consolidating that Perkins loan with their other federal education loans and then the Perkins loan is available for all options under the federal loans,” he says. “Perkins loans do have deferments and forbearances and if you consolidate them, you can get income based repayment.”

Robe explains that consolidation can allow borrowers to better keep track of their loans by minimizing administrative hassle.

“The loan consolidation is an option in terms of getting a long term interest rate, putting all of the loans together and making one single payment rather than trying to keep track of all of your various payments.”

Prioritizing Debt and Borrowing Smart

When it comes to prioritizing debt, borrowers may be inclined to repay loans with the highest interest rates first to save on interest in the long run, says Jarvis.

“I would not recommend that people make payments on their private student loans before they make payments on their federal student loans because of the collection powers of the government being what they are,” she says.

Overall, students and families must be more cognizant of the individual risks associated with taking on increasing debt loads before over borrowing, says Robe.

“Part of default may be being a little naïve but a lot of the time, these are 18 and 19 year olds and the first significant financial liability that they’ve taken on and perhaps some of them are not educated particularly well,” he says. “Traditionally, a college education is considered the ticket to the American dream and I think people need to realize that these aren’t necessarily surefire investments.”